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Predicting Stock Market Returns with Aggregate Discretionary Accruals


  • We thank Abbie Smith (the editor) and an anonymous referee for many constructive comments that have greatly improved the paper. We also thank Brian Bushee, Jason Chen, D.J. Nanda, Ya-wen Yang, and participants at the European Finance Association 2006 Annual Meeting (Zurich), the AsianFA-NipponFA 2008 International Conference (Yokohama), and the 2008 China Finance Review International Conference for useful comments. Liu gratefully acknowledges financial support from the Hong Kong Research Grants Council (HKU 7472/06H and HKU747107H)). All errors remain our own.


We find that the positive relation between aggregate accruals and one-year-ahead market returns documented in Hirshleifer, Hou, and Teoh [2009] is driven by discretionary accruals but not normal accruals. The return forecasting power of aggregate discretionary accruals is robust to choices of sample periods, return measurements, estimation methods, business condition and risk premium proxies, and accrual models used to isolate discretionary accruals. Our extensive analysis shows that aggregate discretionary accruals, in sharp contrast to aggregate normal accruals, contain little information about overall business conditions or aggregate cash flows and display little co-movement with ICAPM-motivated risk premium proxies. Our findings imply that aggregate discretionary accruals likely reflect aggregate fluctuations in earnings management, thereby favoring the behavioral explanation that managers time aggregate equity markets to report earnings.